Stepan Company (SCL) Q2 2021 Earnings Report, Transcript and Summary

Greetings, and welcome to the Q2 Stepan Company 2021 Earnings Conference Call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, July 28, 2021. I would now like to turn the conference over to Luis Rojo, Vice President and Chief Financial Officer. Please go ahead.

Good morning, and thank you for joining Stepan Company’s Second Quarter 2021 Financial Review. Before we begin, please note that information in this conference call contains Forward-Looking Statements, which are not historical facts. These statements involve risks and uncertainties that could cause actual results to differ materially, including, but not limited to prospects for our foreign operations, global and regional economic conditions and factors detailed in our Securities and Exchange Commission filings. Whether you are joining us online or over the phone, we encourage you to review the investor slide presentation, which we have made available at www.stepan.com on the investor section of our website. We make these slides available at approximately the same time as when the earnings release is issued, and we hope that you find the informational perspective, helpful. Now with that, I would like to turn the call over to Mr. Quinn Stepan, our Chairman and Chief Executive Officer.

Thank you, Luis. Good morning and thank you all for joining us. We hope you and your families have had an opportunity to be vaccinated and that you have done so. The best way to protect yourself and your family is to be vaccinated. Although demand for cleaning, disinfection and personal wash products has slowed from the pandemic peak, we at Stepan remained committed to doing our part by supporting customers that supply these essential products to the market. The company had a good first half and delivered record results. Adjusted net income was $84.6 million or $3.62 per diluted share. Both adjusted net income and adjusted earnings per share were up 35% versus the first half of 2020, which was negatively impacted by the Millsdale plant outage. We delivered our best second quarter and had $42.2 million adjusted net income. Surfactant operating income was down 5% largely due to higher North American supply chain cost, driven by inflationary pressures and planned higher maintenance cost. Our Polymer operating income was up 48% on 44% sales volume growth. The polymer growth was driven by both the INVISTA polyester polyol acquisition and organic market growth. Overall, the integration of INVISTA’s business into our company has gone wel, and is on-track with our business plans. Our Specialty Product business results were up due to order timing and improved margins within our MCT product line. Our Board of Directors declared a quarterly cash dividend on Stepan’s common stock of $0.305 per share payable on September 15, 2021. Stepan has increased its dividend for 53 consecutive years. Luis will walk you through a few more details about our second quarter results.

Thank you, Quinn. My comments will generally follow the slide presentation. Let’s start with Slide 4 to recap the quarter. Adjusted net income for the second quarter of 2021 was $42.2 million or $1.81 per diluted share, a 10% increase versus $38.3 million or $1.65 per diluted share in the second quarter of 2020. Because adjusted net income is a non-GAAP measure, we provide full reconciliations to the comparable GAAP measure, and this can be found in Appendix 2 of the presentation and table two of the press release. Specifically, adjustment to reported net income this quarter consists of adjustment for deferred compensation and minor restructuring expenses. Adjusted net income for the quarter excludes deferred compensation income of $1.1 million or $0.04 per diluted share, compared to deferred compensation expense of $1.9 million or $0.08 per diluted share in the same period last year. The deferred compensation numbers represent the net expense related to the Company’s deferred compensation plan as well as cash settled stock appreciation rights for our employees. These liabilities change with the movement in the stock price, we exclude this item from our operational discussion. Slide 5 shows the total company’s earnings fees for the second quarter compared to last year’s second quarter and breaks down the increase in adjusted net income. Because this is net income, the figures noted here are on an after-tax basis. We will cover each segment in more detail, but to summarize polymers and specialty products were up where surfactant was down versus the prior year. Corporate expenses and all others were higher during the quarter due to higher acquisition-related expenses and overall inflation. The Company’s effective tax rate was 24.4% in the first half of 2021 compared to 23.9% in the prior year period. This year-over-year increase was primarily attributable to a less favorable geographical mix of income. We expect the full-year 2021 effective tax rate to be in the range of 23% to 26%. The Slide 6 focuses on Surfactant segment results for the quarter. Surfactant net sales were $384 million, a 16% increase versus the prior year. Selling prices were up 17%, primarily due to improved product and customer mix as well as the pass-through of higher raw material costs. Effect of foreign currency translation positively impacted net sales by 5%. Volume decreased 6% year-over-year. Most of this decrease reflects lower volume into the North American consumer product end market. This reduction was driven by lower demand for consumer cleaning, disinfection, and personal wash products versus the pandemic peak in 2020. Additionally, we continue to experience feedstock supply issues and customer inventory rebalancing efforts. This was partially offset by higher demand for products sold into our institutional cleaning and functional product end markets. Surfactant operating income for the quarter decreased $2.6 million or 5% versus the prior year, primarily due to higher North America supply chain cost as a result of inflationary pressures and planned higher maintenance costs. Latin America operating results benefit from a $2.1 million VAT tax recovery project in the current year quarter. Europe results decreased slightly due to lower demand in consumer products, partially offset by increased demand in functional products. Now turning to Polymers on Slide 7. Net sales were $191 million in the quarter, up 70% from prior year. Sales volume increased 44%, primarily due to 41% growth in rigid polyol volumes. Global rigid polyol volumes, excluding the INVISTA acquisition, was up 7% versus the prior year. Higher demand within the PA and specialty polyol businesses also contributed to the volume growth. Selling prices increased 21% and the translation impact of a weaker U.S. dollar positively increased net sales by 5%. Polymer operating income increased $7.5 million or 48%, primarily due to double-digit volume growth in the legacy polymers business plus INVISTA acquisition. North America polyol results decreased due to rising raw materials and manufacturing costs, partially offset by higher volumes. Europe results increased due to double-digit volume growth from the base business plus INVISTA acquisition. China results decreased due to the non-recurrence of a one-time benefit in the base period in 2020 and lower volumes. China volumes in the first half of 2021 grew 5%. Specialty Products net sales were $21 million for the quarter, up 33% from the prior year quarter. Volume was up 17% between quarters, and operating income increased $3.8 million or 116%. The operating income increase was primarily attributable to order timing differences within our food and flavor business and improved margins within our MCT product line. Moving on to Slide 8. Our balance sheet remains strong, and we have ample liquidity to invest in the business. Our leverage and interest coverage ratios continues at very healthy levels. We had a strong cash from operations in the first half of 2021, which was used for CapEx investments, dividends, share buybacks and investments in working capital, given the strong sales growth and raw material inflation. We executed agreements for $100 million of new private placement debt at a very attractive and fixed interest rate of around 2%. We will use new [ph] cash to fund our organic and inorganic growth opportunities and for other general corporate purposes. For the full-year, capital expenditures are expected to be in the range of $150 million to $170 million. Beginning on Slide 10, Scott will now update you on our 2021 strategic priorities.

Thank you, Luis. We are pleased to have delivered record first half earnings to our shareholders and look forward to carrying that momentum into the second half of the year. We continue to prioritize the safety and health of our employees as we deliver products that contribute to the fight against COVID-19. Our EPA-approved biocide formulation kills a specific novel virus that causes COVID-19 and allow our customers to provide the public with additional tools to protect their families and to fight the pandemic. Based on customer feedback, consumer habits have changed, and these new behaviors require higher use of disinfection, cleaning and personal wash products. Therefore, we believe our surfactant volumes in the consumer product end market will remain higher versus pre-pandemic levels, however, lower than peak pandemic demand in Q2 of 2020. We believe institutional cleaning volume will continue to grow as economies around the world reopen and people demand higher standards for cleaning and disinfection in public settings. We also anticipate that demand for surfactants within the agricultural and oilfield markets will continue to benefit from higher agricultural and commodity prices and improve versus 2020. We will continue working on improving productivity as well as product and customer mix to improve surfactant operating income. Globally, we are increasing capacity in certain product lines, including biocides and amphoterics to ensure we can meet higher requirements from our customers. As discussed previously, we are increasing North American capability and capacity to produce low 1,4-dioxane sulfate, a minor byproduct generated in the manufacture of ether sulfate surfactants, which are key cleaning and foaming ingredients used in consumer product formulations. Through a combination of process optimization and additional manufacturing equipment, Stepan will be prepared to supply customers ether sulfates that meet the new regulatory requirements. This project is the primary driver of our 2021 capital expenditure forecast of $150 million to $170 million and will carry over to 2022 as well. We are working with our customers to ensure these projects deliver our financial return targets. Tier 2 and Tier 3 customers continue to be a focus of our strategy. Tier 2 and Tier 3 volume grew in the second quarter, driven by increased customer penetration. We added 150 new customers during the quarter and more than 500 customers in the first half of this year. Our diversification strategy into functional markets continues to be a key priority for Stepan. During the first half, global agricultural volume increased high single digits with strong growth obtained in the post-patent pesticide segment and new products launched throughout the world. Oilfield volume was up mid-single digits due to higher oil prices. We remain optimistic about future opportunities in this business as oil prices have recovered to the $70 per barrel level. We continued our consulting work in our Millsdale plant and accelerated interventions and investments in both expense and CapEx to increase capacity and improve productivity. We expect to continue this project and investment level throughout the rest of this year. We are projecting a strong return on investment in this project through a combination of productivity improvements, more capacity and several high-margin product lines through debottlenecking key processes and improve service to our customers. We anticipate starting to see the benefits of this project in 2022 and beyond. Polymers had a good quarter and first half of the year as the business is coming back from a challenging year due to COVID restrictions. The long-term prospects for our polyol business remain attractive, as energy conservation efforts and more stringent building codes should increase demand. As Quinn stated, the integration of this business acquired from INVISTA is going well, and we expect to deliver $16 million to $18 million of EBITDA in 2021. Given the strength of our balance sheet, we also plan to continue to identify and pursue acquisition opportunities to fill gaps in our portfolio and to add new platform chemistries. I will now turn the call back to Quinn for closing comments.

Thank you, Scott. The company delivered record first half earnings in 2021. Looking forward, we believe surfactant volumes in North America consumer product end market will be challenged versus peak-pandemic levels in 2020. While we believe institutional cleaning volume will continue to grow versus prior year, we do not believe it will compensate for lower consumer consumption of cleaning, disinfection and personal wash products. We anticipate that demand for surfactants when the agricultural and oilfield markets will improve versus 2020. Global demand for rigid polyols continues to recover from pandemic-related delays and cancellations of reroofing and new construction projects. This recovery, combined with our first quarter 2021 acquisition, should position our polymer business to deliver growth versus prior year. We believe the long-term prospects for rigid polyols remains attractive as energy conservation efforts and more stringent building codes are expected to continue. We anticipate our Specialty Product business results will improve slightly year-over-year. Despite continued raw material price increases and planned higher maintenance costs, we remain cautiously optimistic about the remainder of the year. This concludes our prepared remarks. At this time, we would like to turn the call over for questions. Daisy, please review the instructions for the question portion of today’s call.

Thank you. [Operator Instructions] Our first question comes from the line of Mike Harrison with Seaport Research Partners. Please proceed with your question.

HI good morning. I was hoping that you could walk through some of the pricing and raw material cost dynamics that you were seeing in your two key segments, surfactants and polymers. But overall, pricing was up 20% in the second quarter. How much more pricing do you feel like you need before you can offset the margin impact of higher raws, and maybe what does the timing look like in terms of, I guess, the margin trajectory in both of those segments?

Okay. I will start with that, Mike. Let me just say that the company has implemented price increases July 1 as well. The price increase in surfactants, I would say, is going well, and we are in pretty good shape on our surfactants business. I think in polymers, most likely, we have a little more work to do in Q4 to catch up and maintain and move our margins or restore our margins in that segment, particularly in North America. We are in pretty good shape in polymers and Europe at this point in time.

Alright and in terms of the surfactants business, you mentioned the decline in consumer surfactant demand obviously coming off the peak from the pandemic as well as some inventory destocking. Where do you see that consumer volume compared to pre-pandemic levels once everything stabilizes, especially given your view that we are going to see sustained higher cleaning demand as well as the addition of a lot of Tier 2 and Tier 3 customers that you have brought on over the past several quarters?

Yes, Mike, this is Scott. It is a little bit difficult to project what is going to happen in the second half of the year. We have got economies that we are open and are questioning about restricting going forward. We have economies that still have yet to be open. So it is really hard to predict what it is going to look like going forward. We are in uncharted times. I would say, based on the comments we have made, our business is up versus pre-pandemic levels but below where we saw the peak last year. And if you think about the peak in 2020 that basically emptied a lot of inventories throughout the production supply chain and what inventory is left in the trade at this point and in the consumers’ pantries is yet to be seen. So, I would say it is really hard to predict where we are in that continuum at this point.

But I would say that our customers have told us that they believe that there is a higher demand for cleaning within homes and also within institutional facilities, restaurants, hotels, et cetera. So, we do believe versus 2019, we have seen a sustained increase in cleaning in virtually all end markets that we are participating in.

Alright, and then on the polyols business, it sounds like if we excluded the INVISTA deal, the volumes were maybe up mid-to-high single-digits year-over-year. Maybe not as robust of a recovery as we might expect in some of those construction and rigid polyol applications. Are there either supply chain issues or pandemic issues that are still kind of dragging on construction activity and dragging on volumes within that business?

So if we look at our legacy business, our legacy business was up 7%.

For rigid.

For rigid polyols. So good market growth in your number that you calculated was kind of right on, b. But we have seen some shortage of reaction products that our polyol is reacted within the marketplace, specifically, MDI has been short for periods of time and the pricing in China has been an issue that has negatively impacted our demand. So, we do see -- we are optimistic that we are going to see higher demand throughout the year for our polymer business, but there have been some supply issues on MDI, and I guess that I would also say some on fire retardant ingredients as well.

Yes. And Mike, what I will complement is just the specific rigid polyol business. We had a very strong quarter also on CASE and PA and that takes the whole legacy business, excluding INVISTA, to a very strong double-digit growth because CASE grew very strong and PA as well on top of the 7% in rigid polyols.

Alright and then last question for now is I know you don’t provide guidance, but I feel like you have a lot of moving pieces going on in terms of the earnings comparisons. You posted a couple record quarters here in Q1 and Q2. Obviously, the prior year included the Millsdale outage impact, and then 2021 is including the impact of the Texas freeze, which was also unusual. So can you give us a sense of what your underlying earnings growth would have looked like in the first half without those effects, and maybe give us a little bit more direction on what that should tell us about the pace of earnings growth as we get into the second half?

Great question, Mike. This is Luis. So yes, if you remember last year, we had in the first half, the impact of the Millsdale freeze. And then we had all the insurance proceeds for that event basically in the second half. So, if we move the income to the first half to make sure that we have a clear base, the 35% growth that we are reporting today in adjusted net income on an apples-to-apples basis will be around plus 12%. So, it is a good double-digit growth in our business, and we are happy with a strong double-digit net income growth. And as you know, we don’t provide guidance for the future, but we are providing a lot of perspective about higher maintenance costs this quarter, and for the next couple of quarters, we continue seeing that is going as well versus what we did in Q2. We know Scott provided a little bit more perspective on the volume situation. So - but if we look at the first half, underlying apples-to-apples is plus 12%.

Alright, thanks very much.

Our next question comes from the line of Vincent Anderson with Stifel. Please proceed with your question.

Yes good morning, thanks. I think Mike covered the raw material question pretty extensively there already. But I did just want to make sure in case I missed it, is there any way to quantify some of the impact on revenues rather than margins that basically hit this quarter from either raw material shortage or logistics shortage. So specifically not being able to deliver as much as you wanted to kind of regardless of the price of that raw material?

I think it would be difficult to break that out. But I would say, from an income perspective, shortages in Q2 primarily impacted our ethylene oxide and propylene oxide derivative business. And so I would say those two areas, we probably from an income perspective - operating income perspective, we are probably maybe a couple of million dollars below and that dollar value would be associated with our business in North America and with our business in Mexico.

Okay. That is fair. And I’m looking at what is going on in Germany right now, and you mentioned some MDI and flame-retardant issues, I think, in Asia. Is that something that we should be keeping an eye on or do you feel like that is mostly dealt with, and we are not going to see another kind of likes of the 2018, 2019, where we had just this just the shortage of the kind of co materials for your rigid polyol demand into installation?

This is Scott, Vincent. I would say it is being managed. The plants are operating. They are on plan. Some plants are on scheduled turnaround. So the industry is managing it. I would say it is very tight supply-demand balance at this point. We do expect improvement in the second half, but I would not characterize this as a 2018 type of event.

Okay. That is good to know alright. One more from me, it might be a very short answer from you. But you were linked to a fairly sizable acquisition target I figured I would be remiss if I didn’t try to ask if, one, there had been any validity to that if there is no longer any participation by Stepan in that target? And if so, would you be willing to speak maybe in general terms what drew you to a business of that size and portfolio mix, maybe just as a case study in your M&A strategy?

Yes. So we remain interested in making acquisitions on a global basis, and specifically enhancing our product portfolio. So it was reported in the press that we were interested in an acquisition in Brazil or based on a company in Brazil. I would tell you that our interest for that product line is primarily in North America and so our activities were not as ambitious and a little bit more focused on a geographic perspective than what is reported in the press.

Understood. So that was really just the alkoxlic capacity in Texas, if I remember, then?

Alkoxylation on the Gulf Coast of the United States remains a priority for our Company.

Wonderful. I appreciate the color. Good luck on the rest of the year, gentlemen.

Okay. Thank you very much, Vincent.

Our next question comes from the line of Marco Rodriguez with Stonegate Capital Markets. Please proceed with your question.

Good morning everybody. Thank you for taking my questions. I was wondering if maybe you could expand on a comment if I heard it correctly, when talking about the CapEx expansion here in fiscal 2021, you are obviously guiding to 150 to 170. But I believe I heard some comments that says that should carry into 2022. Can you maybe provide some additional color surrounding that if I heard that correctly?

Marco, the comment from score was basically related to the low 1,4-dioxane project, which is one of the key drivers of the higher CapEx this year. That project will continue the execution in 2022.

Got it and is it too early to quantify maybe what additional spend might be related to that?

Yes. I think we will provide very clear CapEx guidance for next year once we go through the budget and once we have all the projects in and out, we will provide a clear perspective for next year later on.

Got it. Okay. And just kind of circling back around with the price increases and the raw material price increases you guys have spent some time already addressing that. Very much appreciated. Just wondering if you can maybe provide any sort of feedback from a customer standpoint on those increases in terms of them just being obviously resigned to the fact that obviously, it is in the contract, but also something that is an expectation. And if you can maybe perhaps comment on what sort of levels of competition you might be seeing that may be trying to kind of hold your ability to push that through in the second half?

Yes. Marco, this is Scott. I would start off by saying the inflation that our industry has seen in the first six months of this year probably has been unprecedented in the last 15-years. And it is every material and every service that touches a customer or any part of their value chain. And the market is tight as well. You are coming out of a COVID-restricted environment. Inventories were low. You have seen what is happening in the automotive market and the lack of inventory. So it is a wave that all of us are trying to deal with in real-time to the best of our ability. So that is the best way I could describe the environment at this point.

Yes. What I would further say is that I think transportation has been an issue, not only for the whole chemical industry, but I think for the whole supply chain across many different products. And so I think as transportation has been limited in the marketplace, it also has created less flexibility for ourselves and other people to respond to changes in demand. So I would say the environment from a competitive perspective, recognizes that the costs are up. and pricing, we have generally been able to pass through most of the price increases or most of the raw material price increases that we have seen in the market particularly in surfactants and I mentioned earlier, we have more work to do in our polymer business in North America.

Got it. Very helpful. And last quick question for me. If you can maybe just talk a little bit more about your M&A pipeline, just kind of what that looks like versus last quarter in terms of size? And then maybe if you can just address what valuations might look like.

Generally, we have a small number of active projects within our M&A pipeline. We have seen multiples go up significantly over the last couple of years. We are seeing a little bit of maybe plateauing and maybe a little bit of a decrease for certain more commodity assets, I think specialty chemicals remain at relatively peak multiples today. But we continue to look, and we will keep you informed as projects and opportunities are announced in the marketplace.

Yes. And the good news, Marco, is the whole industry is very active on M&A, and there are plenty of projects coming out every quarter. So of course, we will continue being very diligent about our process, and we will engage in those that make sense for us.

I would say, though, don’t look for anything short-term from us.

Got it. Very helpful. I appreciate the time guys. Thank you.

[Operator Instructions] Our next question comes from the line of Mike Harrison with Seaport Research Partners. Please proceed with your question.

Hi. Just a few more for me. One of the things I wanted to understand, you talked about the 1,4-dioxane changes in the capital associated with that. You have been adding some other capacity. Can you quantify how much additional capacity has been brought on in some of these key cleaning and disinfection product lines? And I guess, with the pandemic elevated demand may be running its course, is there still going to be enough demand out there in order to justify the additional capacity?

So what I would tell you is that we have added relatively small amounts of incremental capacity in our biosite area and in our amphoteric product lines, primarily driven by customer request around the world with specific enhancements in Mexico and North America. That is mostly where our capital expansion have been. We have also added some new reactor capability in Brazil to support our agricultural business in that country.

And Mike, specific to 1,4-dioxane, it is not a capacity expansion of our sulfonation network. It is putting a new capability on our existing assets to be able to meet the new regulations. So it is not incremental capacity.

And then the last thing relative to our polymer business, the primary driver for the acquisition of INVISTA’s polyester polyol business was to provide low cost capacity opportunities for us today but also over the next decade, where there is significant excess capacity within the asset that we acquired within Wilmington and there are opportunities to debottleneck and expand the Blesigen Netherlands plant to support our European business.

Alright. Perfect. And then on the agricultural business, it is great to see the volumes higher there. But just trying to understand if this is just strong Ag market fundamentals that is driving that or if it is application wins or geographic expansion or maybe the product of other strategic efforts that we are seeing drive the growth there?

Yes. Mike, it is a little bit of all the above. Commodity prices have risen significantly since last year. Corn soybean prices are 2x of where they were. That is driven increased farmer confidence and really a focus on improving yields per acre, which really comes from their chemical applications. So that is underlining market growth, right. And then there are certain differentiated wins that we are achieving through our targeted initiatives in post pesticide application formulations as well as new emerging smaller customers throughout our international regions. So we have seen the agricultural volumes grow in all four of our regions in the first half.

Alright and then last question I have is on the oilfield business, your slide deck mentions that you are planning a relaunch of the KMCO business sometime in 2021. Can you give a little more detail in terms of the timing and the potential revenue associated with that relaunch?

Yes. I would say a couple of things. One, we are trying to replicate a product line was manufactured in a different facility, KMCO’s old facility. So we have had a lot of R&D and process development work to do in 2021. With the impact of COVID in operations and the supply chain disruptions we have had with potentially raw materials and manufacturing partners, we are a little bit behind our target. However, it is not going to be incremental to 2021. This was more of a rebuilding the supply chain model within the Stepan network, which quite honestly, was more than a 12-month to 24-month time line.

Alright. Thanks very much.

Our next question comes from the line of Vincent Anderson with Stifel.

Yes thanks. I had this thought, and I know you addressed it a couple of quarters ago, but it wasn’t in my notes. So on the 1,4-dioxane, that is a New York state, I want to say, regulation that is driving this. If I’m wrong, correct me, otherwise, the question is, are you already in conversations with either major customers or with regulatory bodies elsewhere in the U.S., where maybe you can actually get ahead of similar regulations in other states and gain market share from this or is this really going to be a just kind of coordinate with the buyers to make sure you are getting paid for the capital that you are having to spend?

So most large consumer product companies, their supply chains are such that they don’t want to have multiple SKUs in the marketplace. So if you think about the vast, vast majority of our customers are going to meet this standard, even though it is just approved in the state of New York, today. They will have one product in their product line that meets the standard for the entire United States. So that is really what the vast majority of our customers are doing. If you take a look at how we have approached this market and this opportunity, this challenge from the marketplace. We work very closely with our customers, and we have to ensure that we get a fair return on the new capital that we are spending to meet the standard.

Understood. I appreciate the clarification. Thank you.

There are no further questions at this time. Please continue with your presentation or closing remarks.

Thank you very much for joining us on today’s call. We appreciate your interest and ownership in Stepan Company. Please stay safe and healthy, wash your hands frequently use disinfectants to clean surfaces and get vaccinated. Have a great day. Thank you.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.